• Our previous strategy report entitled “Gyration Poser?” dated 9 Apr which highlighted limited upside back then with impending headwinds has materialized but admittedly, the pullback magnitude has somewhat surprised due to emergence of additional new issues.

• These old and new external (Fed rate hike, oil price, Grexit and China slowdown) and internal (1MDB, political  glitches, economic soft path in 2Q post GST and 2Q corporate earnings) issues are expected to continue impact sentiment.

• While Fitch upgrade was a positive surprise, other issues are still lingering and most may only climax in 3Q with more clarity. Thus, market is expected to remain lacklustre with potential event driven volatility for most part of 3Q.

• Despite the uncertainties, we still firmly expect EPS growth to remain in the positive territory, albeit single-digit. Corporate earnings should gradually recover from 3Q onwards, in tandem with our expectation of gradual economic normalization in 3Q post GST.

• Moreover, FBM KLCI P/E and P/B valuations are now below mean and near non-crisis trough while both premium valuations vs. regional peers are below mean and near crisis levels.

• Meanwhile, foreign holdings is significantly lower with shareholdings of 23.2% (as at May) as well as cumulative net inflow since Oct 09 down by 62% from peak and only constitute 1.1% of market cap.

• Coupled with ample liquidity and MYR at 17-year low, once more clarity on these issues emerge, the stage will be set for recovery towards year-end or 4Q on the back of economic (and earnings) recovery, tension release and anticipation of 11MP contract/news flow in 2016.

• While repeating the 18-21% surge during previous 3 MPs (10MP P/E as high as 1SD above mean) could be a tall order given lingering issues, we believe mean reversion to our lowered FBM KLCI year-end target of 1,835 (15.5x 2016 earnings) is still achievable.

Strategy

• Conventional wisdom is to prefer yield and defensive during uncertain times. However, given that the benchmark and share prices have plunged and the prospects of Fed rate hike, preference for yield could reduce.
• Moreover, we believe there are opportunities amid the expected uncertainties in 3Q to position for year-end recovery. Thus, we have slightly changed our theme focus to: 1) bombed out stocks (opportunity for valuation normalization when market recovers); 2) 11MP including RAPID (high earnings growth visibility); 3) US$ and raw material (coupled with right fundamental ingredients for earnings growth); and 4) M&A (value enhancing deal).
• Top picks are Edgenta, Evergreen, Homeritz, IJM, KNM, Mitrajaya, MRCB-Quill, SKPetro, TNB & Unisem.